VAT Early Settlement Discount

In the UK, if you allow a discount for early settlement of an invoice (aka prompt payment) then the VAT is calculated on the discounted amount regardless of whether the discount is taken.

Sub Total: 10.00
VAT: 1.80
Net Total: 11.80
10% Early Settlement Discount (ESD)

So the VAT (20% in this example) is applied to 9.00, not 10.00.

However, if the customer pays by instalment, then you must account for VAT at the actual price paid.

Also, if you offer any incentive to a customer, known as an unconditional discount, then the VAT is calculated on the discounted amount provided the customer pays the discounted amount. Otherwise the VAT is calculated on the full value.

Finally there are contingent discounts. If you offer a discount on some contingency, eg. pay x amount by such and such a date, whatever happens, the VAT is calculated on what is actually paid. That of course may mean an adjustment is required in your accounts to accommodate it (eg. the discount taken).

Bear in mind that laws and regulations are subject to change so always check with UK HMRC if in doubt.

Note: it seems that this VAT rule only applies in the UK as I can find no reference to the rest of the Eurozone. Countries like the USA don't suffer from this type of beaurocracy, but note that VAT is being talked about in the States as an alternative to Sales Tax.

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Quentin Pain

Yes you can invoice for the missing VAT, but unless it is significant most people would write it off (in other words account for the extra VAT by taking it off the revenue).

This all depends on how much you need to keep the customer happy, and what is the likelihood of them actually paying it (since they are already on installments).


This was helpful thankyou, Its hard to get your head round when you come to this. From what I have read default to calculating the VAT on the discounted amount, but if someone does pay instalments would you need to re-invoice stating the amended VAT value?

Quentin Pain

Have a read of it again Ghislane. It is not one way or the other, it works both ways: “if you offer… an unconditional discount… then the VAT is calculated on the discounted amount provided the customer pays the discounted amount.” There is more to it than your summary in other words.

Now, for examination purposes, some exams I have seen have got it wrong! but mostly they work on the simplest principle, which is, if you offer an ESD then assume the discounted VAT is applied. I would use that if you are in any doubt (and I am not in the least surprised if you or anyone else would be!). If there were some solid standards here, the different examiners would get some consistency. You have my sympathy.

ps. I chose to use the discounted method when taking my level 1 exam a while ago and that was one of the reasons I got a distinction. You can do it too. Good luck.


Hi there,

I’m currently at this stage in my training, however in my studying they still discount the Vat although the customer has not taken out early settlement discount. I’ve flagged it up because it didn’t sound right and they said yes due to Hmrc trying to cut out red tape. Still doesn’t sound right so ive just come across here and your saying different that discounts only apply if ESD is taken.

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